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Review: Par Syndicate EIS Fund

Archived article

Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.

These days investors are overwhelmed with brilliant new
ideas promising to be the next big thing. A start-up destined to be the next
Facebook; a gadget touting itself as the new iPod; a drug promising to change
the face of medicine. The skill lies in selecting investments with real potential
to unlock commercial opportunities, not just big ideas.

That’s where Par Equity, the managers of the Par Syndicate
EIS Fund, believe they can help. They aim to marry innovation with commercial
opportunity. The fund invests in innovative SMEs with high growth potential, alongside seasoned entrepreneurs. They
invest in what they call the “equity gap”. This is the area beyond the reach of most business angels but not quite big
enough for private equity to be interested.

Par Equity has a relatively cautious approach to these early
stage technology businesses, although the fund remains a high risk, high
potential return investment. The fund
steers clear of companies with over-egged valuations favouring those with
defensible intellectual property, a proven track record of sales and a positive
response from early adopters or consumers.

Highlights

Growth EIS opportunity centred around innovative
technologies

Co-investment strategy with proven business
angels

Record of exits

Marries innovation and commercial opportunity

Minimum £20,000

The manager

Based in Edinburgh, Par Equity provides both intellectual
and financial capital to early stage companies. Par made their first investment
in March 2009 and launched the EIS fund in late 2012. The fund was primarily
formed to invest alongside the Par Syndicate.

Par Equity­­­­
source deals for successful entrepreneurs or high flyers who are looking to
reinvest the proceeds of a business sale or their earnings. These Business Angels
make up the Par Syndicate, currently 110 people. Broadly speaking half are
entrepreneurs who have realised their businesses and the other half are professionals
(e.g. high-ranking lawyers and accountants).

They are central to the investment process. On the one hand,
they provide Par Equity with deal flow. For instance, if an entrepreneur or
group of entrepreneurs come up with a new mobile app, they may approach a
member of the syndicate who has previously had success in that area. The member
in turn will pass the opportunity, alongside their views, on to Par Equity.

On the other hand, the Business Angels offer intellectual
capital and skills Par Equity may not have in-house. The investment team has a
great deal of experience but concede they will not have a firm handle on all
the technologies they see. So, they will ask the Par Syndicate to validate the
technology and market opportunity they are looking at.

Strategy

Investments are made in companies which are largely generating revenue but are pre-profit at the point of investment. Par Equity tend to
participate in investment rounds of at least £0.5 million. The fund is largely
sector agnostic but will not participate in biotech or anything Par Equity deem
to be morally dubious: the manufacture of armaments or weapons technology for
instance.

Before considering an investment, Par Equity will ask
two key questions. Firstly, does the idea or technology have a competitive advantage?
Secondly, is there a buyer for it?

Geographically, they believe there is an arc of opportunity
from Belfast through the North West of England up into Scotland. Businesses
within the area operate from lower-cost properties, employ smart people for
less and don’t succumb to the hype sometimes afforded to businesses in the
South East.

Moreover, Par Equity, whilst focused on UK businesses, look
for companies with the potential to go global. They argue you can easily do
that outside London.

To take advantage of this opportunity, Par Equity use a
collaborative co-investment model.

They won’t invest unless Angels in the network are also
investing. This provides an extra layer of due diligence and the Angel
investments should help ensure investee companies don’t become lifestyle
businesses.

Par Equity argue that if an investment manager simply doles
out funding to ten businesses they will focus predominantly on only one or two.
They may not intend to but it is only natural. Some will do better than others.

By having an Angel invested there is a party with skin in
the game. The Angel is very unlikely to have participated in all the deals. So,
their investment should be one of their main priorities. As such, they will
monitor and tend to it closely.

Additionally, support for investee companies will be given
by Par Equity’s Advisory Panel. This is formed from the Angel network and
comprises individuals interested in taking a more active role in supporting the
businesses. Investee companies need different levels of support from different
areas at various times and access to a flexible pool of expertise should be a
benefit.

Typically, Par Equity will appoint someone to the
board of investee companies. Usually this is an Angel who has invested but may
be a member of staff.

Investors in this EIS can expect exposure to six or seven
underlying companies. One of the six or seven underlying companies is likely to
be pre-revenue or at an even earlier stage. If this business goes well, it can
really fly. If it doesn’t investors should expect a total loss (ignoring the
tax reliefs). From a portfolio construction perspective, this can be a sensible
approach. Furthermore, no investee company will account for more than 25% of an
investor’s portfolio.

The nature of businesses in the portfolio mean the first
round of funding is unlikely to be the last. Future rounds may dilute existing
investments. Par Equity aim to allow existing investors to participate directly
in follow on funding, outside the fund.

Exits will be sought through trade sales. It’s hard to put a
timeframe on exits given the type of investee businesses in the portfolio.
Anywhere between three-eight years is likely so investors should be prepared
for long term.

Track record

In June 2016, Par Syndicate EIS had its first exit – PathXL.
PathXL provides cancer detection software. Their software, TissueMark, allows
pathology labs to use digital scanners and identify tumours in a growing number
of cancer types. Par Syndicate EIS fund invested in November 2012 and investors
received a significant return on investment when PathXL was acquired by Philips
in June 2016. Remember, past performance is not a guide to the future.

Par Equity have also exited investments pre-dating their
EIS. Of those investments, two would have qualified for EIS.

At the end of 2016, Par Equity had deployed capital in 39
companies and exited 8. One was written off. Three were insolvent. The
remaining seven provided healthy returns with four providing better than
targeted multiples.

One failure was an investment in a company called Shaw Water,
a technology that automatically tested water for impurities. It was an
innovative product but didn’t work as planned.

As a consequence, Par Equity are now much more cautious of novel
products. Before investing they will look for strong evidence it is attractive
to purchasers and use revenues, however small, as a proxy for working out if
something does what it says on the tin.

Investors should be aware they will only have exposure to
new businesses, not the current portfolio.

A recent success story –
and a company with the characteristics Par Equity look for – is Snap40. Snap40
is a wearable health monitor used in hospital wards. It monitors more vital
signs than any other single wearable device on the market including changes in
systolic blood pressure, blood oxygen saturation, respiratory rate, heart rate,
temperature, body movement and perspiration. It claims its competitors offer
reactive alerting, only sending notifications once a patient becomes sick.
Snap40 on the other hand is proactive, continuously calculating a patient’s
risk of becoming sick.

Notifications of patients at risk of deterioration allow
healthcare staff to intervene. The company has won an £80,000 contract from NHS
England with additional revenue potential of £1 million. Clinical evaluations should be completed by Q4 of 2016 and the company are
hoping to begin UK sales by the beginning of April.

In addition, the company has commercial and sales interest
from a wide range of healthcare providers including Bupa (UK), the Cleveland
Clinic (USA) and the Mayo Clinic (USA).

Fees

There is an initial charge levied against the
investor of 1.0% and a 5.0% arrangement fee taken from the investee companies.
Four years of annual management charges of 0.75% are taken from the investor
upfront. On a £100,000 investment £96,000 is eligible for 30% income tax relief
but the deductions are not. This is not unusual for this type of EIS. Monitoring fees of the larger of 1.25% of the investment or
£6,000 per annum are payable by the investee company. This may be as much as
£12,000 where a staff director is appointed (this is rare though).

A 20% performance fee is due on all net proceeds received by investors. If an exit is achieved before the 3 year EIS qualifying term the hurdle for the performance fee is raised by 40% to compensate for the loss of tax relief.

Dealing fees and annual administration charges are also payable to the fund’s administrator. Par Equity bears the cost of the dealing fee on investment and the first four years’ administration charges, but the dealing fee on, for example, an exit is borne by the investor and deducted from the exit proceeds.

Risks

Investors need to be aware their capital is at risk. They are investing in early stage technology businesses. Should the technology fail or the IP become
worthless then the investment will retain little or no value.

Earlier-stage companies usually take longer to mature and
investors should not expect clock-like exits in three to four years.

The usual risks with unquoted companies exist with this EIS
offer. For instance, EIS investments are illiquid and there is a risk of losing capital.
Investors should only invest money they cannot afford to lose. Tax benefits
will depend on individual circumstances and tax rules can change.

Our view

Par Equity’s approach to technology investing is refreshing, in our view.
Focusing on the commercial viability of a technology and following a strict
investment process, with the aid of their network, Par Equity offer investors a
sensible approach to technology investing. The strategy does mean they may miss
a real gem. However, this also means they are less likely to pick too many disasters.

Though the track record is still relatively short, it has
certainly shown positive signs.

Wealth Club aims to make it easier for
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– tax-efficient investments. You should base your investment decision on the
provider's documents and ensure you have read and fully understand them before
investing. This review is a marketing communication. It is not advice or a
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is thus not subject to prohibitions on dealing ahead of its dissemination.

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